Malaysia's Court of Appeal reverses High Court BBA ruling

By Habhajan Singh (Available at http://epaper.themalaysianreserve.com/ also at: http://islamicfinanceasia.blogspot.com/)

The Court of Appeal had on Mar 31 reversed an earlier High Court decision that Al-Bai Bithaman Ajil (BBA) contracts were contrary to Malaysia’s Islamic banking regulations. The move will certainly be a relief to local Islamic banks that had earlier feared a potential spike in defaults of Islamic contracts, especially for home financing. The unanimous decision in the appeal in the Bank Islam Malaysia Bhd v Ghazali Shamsuddin & 2 Others, and nine other cases, would mean that Islamic banks need not worry about the possibility of a string of defaults in BBA-based financing on the basis that the facilities are not Shariah-compliant. In Tuesday’s [Mar 31, 2009] appeal, Bank Islam Malaysia Bhd (Bank Islam) had 10 cases bundled together in the appeal before Court of Appeal judges Datuk Md Raus Sharif, Datuk Abdull Hamid Embong and Datuk Ahmad Maarop. The Malaysian Reserve first reported on Sept 8, last year on the BBA judgment by High Court judge Datuk Abdul Wahab Patail, that sent shockwaves through the local Islamic banking fraternity as they began deciphering its impact.

Before that, many Islamic finance bankers and lawyers had not seen Abdul Wahab’s 54-page written judgment dated July 18, but which was made available to lawyers involved in the case only sometime in August. Upon winning the appeal, Bank Islam yesterday issued a two-paragraph statement saying: “Customers of Bank Islam and the public at large can now take comfort from the certainty that Bai Bithaman Ajil (BBA) contracts are valid and binding. “This follows the unanimous decision by judges of the Court of Appeal on March 31, 2009, during a proceeding involving Bank Islam. The said decision reaffirmed that Bank Islam’s practices in relation to BBA contracts are Shariah-compliant and valid. “The Court of Appeal also reiterated that a BBA contract is a sale transaction and therefore must not be compared to a loan transaction.”

Bankers at outfits like Maybank Islamic Bhd, CIMB Islamic Bhd and RHB Islamic Bank Bhd were jolted by Abdul Wahab’s ruling that the application of the BBA contracts in Arab Malaysian Finance Bhd vs Taman Ihsan Jaya & 2 Others (2008), and 12 other cases, were contrary to the Islamic Banking Act 1983 (IBA). Abdul Wahab had argued that since some BBA contracts were structurally faulty, defaulters need not pay more than the original financing amount that they received, depriving banks of the profit they would have otherwise booked from the transaction. Bankers feared that this could mean that current BBA financing clients would only need to pay the facility amount and would escape from paying the profit portion.

BBA is a hugely popular Islamic financing contract in Malaysia, though it is not accepted in many other jurisdictions, including most of the Middle East. In Malaysia, BBA has been the underlying concept for most Islamic financing in the last two decades. Since Abdul Wahab’s judgment, there has been some shift away from BBA. Towards the end of 2008, RHB Islamic, for example, completely phased out BBA in favour of the musharakah mutanaqisah concept for its home financing products. At the full hearing on Tuesday, Mohamed Ismail Shariff from the law firm Skrine appeared as the lead counsel for Bank Islam, assisted by Oommen Koshy and Arief Emran, while Harpal Singh Grewal and Harminder Kaur appeared for one of the respondents. In this instance, the Arab Malaysian Finance Bhd v Taman Ihsan Jaya case proper was not one of the cases before the Court of Appeal.

When contacted, Ismail said the Court of Appeal ruled that the BBA agreement is valid as it is being done now, even without a novation agreement. Post Abdul Wahab’s BBA judgment, some banks were considering including a novation agreement in future BBA contracts as it was cleared by the judge. “It also ruled that the amount that the bank is entitled to demand upon a default is the balance of the bank’s selling price, subject to the bank giving an ibra [CORRECTED] or rebate, upon payment being received or realised,” he said. In the earlier judgment, Abdul Wahab had ruled that the sale element in the BBA is “not a bona fide sale” and had brought into question the profit portion of the facility. Bank Negara Malaysia (BNM), which regulates the Islamic finance sector, was involved in the hearing as an intervener. It was represented by Karlos Israphil Bendlin from Zaid Ibrahim & Co. Association of Islamic Banking Institutions Malaysia [and not Institut Bank-Bank Malaysia (IBBM) as reported in original TMR 2/4//09 report] had also sent a counsel holding a watching brief.

Technically, the respondents can still appeal to the Federal Court, the highest court of the land. However, initial checks show that this is not likely to happen. The BBA financing is a contract of deferred payment sale (the sale of goods on a deferred payment basis) at an agreed selling price, which includes a profit margin agreed on by the customer and the bank. Profits in this context is justified since they are derived from the buying and selling transaction as opposed to interest accruing from the principal lent out.

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Salam Zul,
This is a process of evolution. Malaysia being a developed market for Islamic Finance need these test cases to break itself from the debt-based financing and innovate more equity-based financing techniques. Although the final ruling validate the controversial BBA financing method the bankers should start to realise that Islamic finance and economy is not all about profit but achieving the balance of justice and fairness in the well-being of ummah. A trader must not all think about making profit but also helps his customer to prosper so that he could see the customer to come and do business with him again.